Employer Financed Retirement Benefit Scheme Background

HMRC is currently sending letters to companies that have made contributions to Employer Financed Retirement Benefit Schemes (EFRBS) that outline an opportunity to settle the taxation treatment of these contributions under one of two possible treatments. These letters specifically concern cases in which corporation tax deductions have been claimed for contributions to an EFRBS without a corresponding income tax charge on beneficiaries.

In these situations, the availability of corporation tax relief depends on the interpretation of a specific piece of tax law. This legislation has been widely interpreted as allowing a corporation tax deduction in situations where a payment was made “under an EFRBS” regardless of whether or not such a payment triggered an income tax liability. Accordingly, corporation tax relief has often been claimed in situations whereby a payment has been made under an EFRBS, such as to a trust, or an investment wrapper, that does not trigger an income tax charge on a beneficiary.

In its 2009 Spotlight 6 publication, HMRC stated its view that corporation tax relief is only available if beneficiaries have received payments that are subject to an income tax charge, but Spotlight 6 does not carry legislative weight. While HMRC has investigated a large number of these cases, none have so far made it to court. This means that HMRC has not successfully argued its position in court, but equally, the counter-position has never been successfully defended. It is worth noting that HMRC has subsequently changed the relevant piece of legislation to be certain that its interpretation is correct going forward.

In the last year, HMRC has in some cases tried another attack by arguing that the payment under an EFRBS should be subject to an income tax charge. This would allow the corporation tax deduction to remain but at the cost of a larger income tax liability. Interestingly, in its settlement letter HMRC does not seem at all sure of the validity of this argument. On the face of it, the second treatment available under the settlement option is based on this argument, but the settlement letter uses a subtly different approach.

Current Position onEmployer Financed Retirement Benefit Schemes

HMRC’s position on EFRBS now seems to be as follows:

HMRC does not want corporation tax relief to be available without a corresponding income tax charge on a beneficiary.

HMRC argues that the legislation supports its view but has not yet chosen to test this in court and has also changed the legislation to support its view for future cases; hardly a glowing endorsement of the original legislation.

In recent cases, HMRC has moved to another angle of investigation. These facts could be taken to mean that HMRC is not entirely sure of the strength of its argument.

HMRC’s new approach to these investigations is not considered sufficiently robust to be included as one of the two authorised treatments under the settlement offer.

This means that an impasse has been effectively reached in HMRC investigations. It appears that HMRC is committed to achieving the taxation treatment that it wants for these cases, but is hesitant to test the strength of its argument in court. However, HMRC has resources of time and personnel that are not available to most companies that have made EFRBS contributions, meaning that it is by no means impossible that if HMRC chooses to press the point in court it would win.

The settlement opportunity appears to be HMRC’s attempt to avoid the risk of testing its argument, or at least minimise the cost of failure, by reaching an agreement with as many cases as possible, on terms that, while largely avoiding penalties, achieve HMRC’s goal in terms of taxation treatment.

HMRC has recently announced new proposals, to be published in 2014 that could force immediate acquiescence to HMRC’s treatment on all users of such arrangements if HMRC successfully argues its case in court.

EFRBS Settlement Offer

It is important to note that the settlement opportunity is not a chance to “haggle” with HMRC. The guiding principle of such offers is that the agreed payment must adhere to an arguable taxation treatment. HMRC is prepared to accept the settlement based on one of two possible treatments.

Treatment 1

The company accepts HMRC’s original argument that no corporation tax deduction should have been granted on the contributions. It is very likely that this will be the cheapest option in the short term, since the company will be incurring a corporation tax rather than an income tax charge, and corporation tax rates are far lower. In all other ways, the EFRBS remains in place as originally intended, and beneficiaries will be subject to income tax as and when they take benefits from the EFRBS. When income tax is charged on benefits, a corresponding corporation tax deduction should be available.

Treatment 2

This is similar to HMRC’s recent approach to some EFRBS investigations but rather than being based on an argument that income tax should be charged on all payments under an EFRBS, HMRC asks the company to accept that the contributions to the EFRBS were not for the purpose of providing retirement benefits. This means that rather than being treated as contributions to an EFRBS the payment should be treated as normal remuneration payments and accordingly PAYE and NIC would be due.

This is a far more complicated route as it leads to issues as to who pays the PAYE and NIC and possible double taxation when future benefits are taken from the trust. This is probably going to be a more immediately expensive option and will require more complicated negotiation with HMRC to agree on a future treatment of benefits.

Both settlement options could have IHT implications, but we feel there are arguments that HMRC does not seem to have considered that would negate these impacts.

HMRC has stated that the settlement offer is based simply on contributions that have been made to an EFRBS and does not cover any additional actions that may have been taken, possibly involving complicated loan structures or gold-based transactions. If such steps have been taken HMRC is open to a settlement but the negotiations will be more complicated.

Conclusion on EFRBS

It is very likely that the corporation taxation treatment of contributions to an EFRBS will be decided in court. Unless HMRC achieves a very high success rate from these settlement offers it will probably be forced to press ahead with action eventually. HMRC is not guaranteed of success. We have described above that even HMRC does not seem convinced of the strength of its case, but its resources mean that a victory is certainly possible, and even if HMRC loses, the costs and time involved could make it a pyrrhic victory for the tax payer. Alternatively, HMRC could quite conceivably lose, meaning that corporation tax deductions would remain in place with no income tax charge until benefits are taken.

This settlement offer is a chance for companies to remove themselves from the uncertainty. HMRC will generally not look to impose penalties if companies chose to settle but interest will be payable. We can not make a decision for companies on this matter, as ultimately the choice will depend on how they judge risk, but we can inform companies of the taxation consequences of all possible outcomes, including penalties where appropriate and highlight any special circumstances, unique to their case that may push the balance of decision in a specific direction.

As had been expected, the 2018 Spring Statement update did not include any major tax policy announcements; rather it provided a number of consultations that suggest potential legislative changes in the future. Read more about the areas set for exploration here.